Question

1. What are the key elements that determine if we should process an item further or sell it at the split off point?

2. What are the key points we should consider in deciding whether to accept a special order?

Answer 1

Answer 1

The key elements that determine if we should process an item further or sell it at the split off point are:-

• Additional cost of processing This implies to the extra cost which shall be incurred by the factory to further process the item . If the cost thus incurred is determined to be incomprehensible then the item should be sold at the split off point because at the end the factory's ultimate goal is to maximize wealth
• Net increase in sales value after processing:-This refers to the additional sales value increment in the item thus processed giving a wider target market for the sales of the product processed . If the profit margin increases then the product must be sold after processing otherwise at the split off point
• Economical feasibility:- This is to check whether it is economically feasible or achievable to further process the product . While checking for this feasibility financing options should also be weighed
• Infrastructure feasibility:- This is to check that whether it would be feasible to create such infrastructure so as to further process the product

• By doing A sell-or-process-further analysis

A sell-or-process-further analysis can be carried out in three different ways:

Incremental (or Differential) Approach calculates the difference between the additional revenues and the additional costs of further processing. If the difference is positive the product must be processed further, otherwise not.

Opportunity Cost Approach calculates the difference between net revenue from further processed product and the opportunity cost of not selling the product at split-off point. If the difference is positive, further processing will increase profits.

Total Project Approach (or the comparative statement approach) compares the profit statements of both options (i.e. selling or further processing) separately for each product. The option generating higher profit is chosen.

Answer 2

When deciding whether to accept a special order, management must consider several factors:

• The capacity required to fulfill the special order
• Whether the price offered by the buyer will cover the cost of producing the products
• The role of fixed costs in the analysis
• Qualitative factors
• Whether the order will violate the Robinson-Patman Act and other fair pricing legislation